The finance classroom meets the outside world (and vice-versa). Back away slowly from the computer with your hands up and your mind open, and with luck nobody gets hurt.

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Saturday, March 19, 2005

Market Efficiency, Market Evolution, and Baseball Labor Markets

Jim Mahar at Financeprofessor.com points us to an article on SSRN by Hakes and Sauer, titled "An Economic Evaluation of the Moneyball Hypothesis". Here's the abstract"

Michael Lewis's book, Moneyball, is the story of an innovative manager who exploits an inefficiency in baseball's labor market over a prolonged period of time. We evaluate this claim by applying standard econometric procedures to data on player productivity and compensation from 1999 to 2004. These methods support Lewis's argument that the valuation of different skills was inefficient in the early part of this period, and that this was profitably exploited by managers with the ability to generate and interpret statistical knowledge. This knowledge became increasingly dispersed across baseball teams during this period. Consistent with Lewis's story and economic reasoning, the spread of this knowledge is associated with the market correcting the original mis-pricing.

Billy Beane, the Oakland GM was one of the first to employ computers to crunch statistical data on ball players. As a result, he was able to exploit inefficiencies in the market, and to identify mispricings (i.e. buy the talent he wanted at a relatively reasonable price). After a while, the same approach was adopted by most teams in the league. So, the strategy stopped providing "abnormal returns". Now, since everyone uses this approach, a team must also use it or end up behind.

The parallel to financial markets is clear - an inefficient markets can be exploited at first by new "technology" (I use the term in the general sense to include hardware, software, and new methodologies like valuation models) . If there'is money to be made, the abnormal profits due to a mispricing dissappear over time. Once people know about the mispricing, it disappears.